Two common investing strategies are growth investing and value investing. While both have the same objective of increasing principal, they each have different ways of achieving that goal.
Growth investing
Growth portfolios invest in corporations whose profits are expected to grow rapidly. This generally includes such companies as pharmaceuticals, technology, and health care. Value investing covers stocks of companies that are cheap relative to their earnings, dividends, book value, and cash flow. Value stocks are usually found in market sectors such as finance, energy, or basic materials.
Since public sentiment plays a part in fluctuating stock prices, the nameless and faceless public has a sizeable role in determining the success of growth investing. In practice, this means that growth holdings tend to be expensive relative to book value and cash flow. This is because investors tend to pay more if they expect a company to rapidly increase its earnings. If a company has a “negative surprise” – failing to match expected earnings – its price drops dramatically.
Value investing
Value stocks are priced differently. Relative to their earnings expectations, they sell for below-average prices. The value investor doesn’t necessarily know when a company will change from being under- to over-valued, but invests when its price appears low and value high. The value investor has confidence that other investors will also discover this company trading below its potential, and has the patience to wait until this happens and the price rises. This is similar to what the stereotypical Jewish grandmother preaches, “If you want a better price, buy straw hats in the winter.” The most famous “value investor” is billionaire Warren Buffet. If you want to follow in his footsteps, remember his quote: “Price is what you pay. Value is what you get.”
The popularity of value or growth investing changes depending on many factors. The most important determinant of the market, however, may not be what’s going on in the economy today. Rather, the stock market is often called a “leading indicator,” meaning that it moves based on how investors feel the economy will do in the future. A look at 2013 shows that even if the economy wasn’t strong, people generally felt optimistic and were willing to bet their money on the future. Whether you want to pitch your tent in the value camp or the growth camp, or a little in both, you should keep an eye not just on where stocks are priced today, but where you think they’re heading in the future.
Douglas Goldstein, CFP®, is an investment advisor and author of Rich As A King: How the Wisdom of Chess Can Make You a Grandmaster of Investing.
Douglas Goldstein, CFP®️ is the director of Profile Investment Services, Ltd. www.Profile-Financial.com He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation on how to set up your American assets to meet your financial goals. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.
Published August 4, 2014.